Pricing the US Legal System

ByPeter L. Kahn, Peter L. Kahn, an economist, is an assistant professor of law at the Catholic University School of Law in Washington.September 11, 1992

LAWYERS, America's favorite scapegoats, have been charged by the Bush administration with inflicting some truly astounding costs on our economy. According to Vice President Dan Quayle, the legal system costs our country some $300 billion a year. "Every American knows the legal system is broken," he told the Republican convention, "and now is the time to fix it."

Of course the system isn't perfect, but it's sure not as broken as the vice president claims. Those gargantuan cost estimates are meaningless. The true numbers are vastly smaller.

The administration used numbers published by tort-reform advocate Peter Huber, who relied on estimates made by an insurance consulting firm. That firm estimated the "direct" costs of the tort system - actual out-of-pocket expenses, including damage awards - at some $117 billion. Huber then figured "indirect" costs of efforts to avoid liability at about $300 billion.

To defendants, the "direct" cost of the tort system certainly includes the damage awards they pay plaintiffs. But don't plaintiffs get some benefit from all that money? The cost to society can't include pure transfers of resources from one member of society to another. Yet the administration treats this transfer as if it were a real cost.

This correction is not small. The Rand Corporation estimates that damages paid to plaintiffs constitute half the direct cost of the tort system. On that basis, nearly $60 billion should be cut from the estimate of "direct"costs.

An even greater correction is necessary for so-called "indirect" costs. A substantial portion of these avoidance costs simply can't be attributed to the tort system - indeed, they largely reflect a benefit to society, not a cost.

Suppose there were no tort system, and injured persons couldn't sue. People would try to protect themselves, and incur costs to avoid being injured. The injury-avoidance costs attributable to the tort system includes only the additional resources spent, over and above what people would spend to avoid injuries anyway.

How big are these extra costs? No one knows, but they're probably tiny - if, indeed, there is any net cost at all.

The key question is, which party - the potential injurer, or the potential victim - can prevent an injury most cheaply? The tort system raises avoidance costs only if courts hold the injurer liable when the victim could have prevented the injury more cheaply.

But what if the potential injurer could prevent injuries at a lower cost? Making that party liable would lower costs by giving the cheaper injury-avoider incentive to avoid the injury. Society should count those savings as a benefit of the tort system, not a cost.

Savings made by holding liable defendants who can prevent injuries relatively cheaply should offset the extra costs from holding relatively expensive injury-avoiders liable. If the courts get it right just half the time, in other words, there is no indirect cost of the tort system, because the savings from the "right" decisions just balance the extra costs from the "wrong" decisions.

On this assumption, and excluding damage awards, the tort system costs society less than $60 billion, not $300 billion - not a bad bargain, perhaps, compared to the costs the injuries prevented would inflict.

Of course, if judges get it right a bit more often (which seems likely), they'll usually assign liability to the "right" party - in which case the tort system generates an indirect benefit, not a cost reaching into the hundreds of billions of dollars a year.

Clearly, the administration is counting costs to potential defendants as if those were the costs to the whole society. It's a revealing error. What better way to argue for special-interest legislation than to treat that interest group's problem as if it were a national emergency?

Do these "costs" hurt our international competitiveness? Not really. If the tort system disappeared tomorrow, potential victims would spend more to protect themselves. The American economy would not necessarily be more competitive - just those escaping liability would be. Potential victims, who would have to spend more to protect themselves, would have higher costs and would be less competitive. And maybe that redistribution is what this whole game is about anyway.

We should judge programs by their value to our whole society - not just to the interest groups most eager to see them adopted. When we do, the case for litigation reform looks a whole lot weaker than the administration maintains.